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RCKB > SEC Filings for RCKB > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for ROCKVILLE FINANCIAL, INC. /CT/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ROCKVILLE FINANCIAL, INC. /CT/


8-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand Rockville Financial, Inc., our operations and our present business environment. We believe accuracy, transparency and clarity are the primary goals of successful financial reporting. We remain committed to transparency in our financial reporting, providing our stockholders with informative financial disclosures and presenting an accurate view of our financial disclosures, financial position and operating results.

MD&A is provided as a supplement to-and should be read in conjunction with-our Unaudited Consolidated Financial Statements and the accompanying notes thereto contained in Part I, Item 1, of this report as well as our Annual Report on Form 10-K for the year ended December 31, 2012. The following sections are included in MD&A:

Our Business - a general description of our business, our objectives and regulatory considerations

Critical Accounting Estimates - a discussion of accounting estimates that require critical judgments and estimates.

Operating Results - an analysis of our Company's consolidated results of operations for the periods presented in our Unaudited Consolidated Financial Statements.

Comparison of Financial Liquidity and Capital Resources - an overview of financial condition and market interest rate risk.


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Our Business

General

By assets, Rockville Financial, Inc. is the third largest publicly traded banking institution headquartered in Connecticut with consolidated assets of $2.18 billion and stockholders' equity of $297.0 million at June 30, 2013. The Company delivers financial services to individuals, families and businesses throughout Connecticut and the region through its 22 banking offices, its commercial loan production office, its mortgage loan production office, 38 ATMs and internet website (www. rockvillebank.com). The Company's common stock is traded on the NASDAQ Global Select Stock Exchange under the symbol "RCKB."

The Company strives to remain a leader in meeting the financial service needs of the community and to provide superior customer service to the individuals and businesses in the market areas that it has served since 1858. Rockville Bank is a community-oriented provider of traditional banking products and services to business organizations and individuals, offering products such as residential and commercial real estate loans, commercial business loans, consumer loans and a variety of deposit products. Our business philosophy is to remain a community-oriented franchise and continue to focus on providing superior customer service to meet the financial needs of the communities in which we operate. Current strategies include expanding our banking network by pursuing new branch locations and branch acquisition opportunities in our market area, continuing our residential mortgage lending activities which comprise a majority of our loan portfolio and continuing to expand our commercial real estate and commercial business lending activities and growing our deposit base.

The Company's results of operations depend primarily on net interest income, which is the difference between the income earned on its loan and securities portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Company's provision for loan losses, income and expenses pertaining to other real estate owned, gains and losses from sales of loans and securities and non-interest income and expenses. Non-interest income primarily consists of fee income from depositors, mortgage servicing income, mortgage origination and loan sale income and increases in cash surrender value of bank-owned life insurance ("BOLI"). Non-interest expenses consist principally of salaries and employee benefits, occupancy, service bureau fees, marketing, professional fees, FDIC insurance assessments, other real estate owned and other operating expenses.

Results of operations are also significantly affected by general economic and competitive conditions and changes in interest rates as well as government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect the Company. Uncertainty and challenges surrounding future economic growth, consumer confidence, credit availability, competition and corporate earnings remains. Management believes that overall credit quality continues to be somewhat affected by weaknesses in national and regional economic conditions, including high unemployment levels, particularly in Connecticut.

Our Objectives

The Company seeks to continually deliver superior value to its customers, stockholders, employees and communities through achievement of its core operating objectives which are to:

Grow and retain primary households to increase core deposit relationships with a focus on checking, savings and money market accounts for personal, business and municipal depositors;

Build high quality, profitable loan portfolios using primarily organic growth and also purchase strategies, while also continuing to build efficiencies in its robust secondary mortgage banking business;

Build and diversify revenue streams through development of banking-related fee income, in particular, through the expansion of its financial advisory services and introduction of private banking professionals;

Maintain expense discipline and improve operating efficiencies;

Invest in technology to enhance superior customer service and products; and

Maintain a rigorous risk identification and management process.

Significant factors management reviews to evaluate achievement of the Company's operating objectives and its operating results and financial condition include, but are not limited to: net income and earnings per share, return on equity and assets, net interest margin, non-interest income, operating expenses related to total assets and efficiency ratio, asset quality, loan and deposit growth, capital management, liquidity and interest rate sensitivity levels, customer service standards, market share and peer comparisons.


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Regulatory Considerations

Rockville Financial and its subsidiaries are subject to numerous examinations by federal and state banking regulators, as well as the Securities and Exchange Commission. Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for additional disclosures with respect to laws and regulations affecting the Company's businesses.

It is difficult to predict at this time what specific impact certain provisions the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on the Company, including any regulations promulgated by the Consumer Financial Protection Bureau. The financial reform legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply additional resources to ensure compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

In June 2012, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation approved three proposals that would amend the existing capital adequacy requirements of banks and bank holding companies. The three proposals would, among other things, implement the Basel III capital standards, as well as the standardized approach for almost all banking organizations in the United States. The proposal would increase the minimum levels of required capital, narrow the definition of capital, and place greater emphasis on common equity. The Basel III standardized proposal would modify the risk weights for various asset classes.

In July 2013, the three Federal bank regulatory agencies (the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation) approved the final Basel III rules that amended the existing capital adequacy requirements of banks and bank holding companies for smaller banks as defined. The new rules will become effective for smaller banks and bank holding companies on January 15, 2015, a year after their application to larger banks. Final rules for large banks are expected to be finalized by the end of the third quarter 2013. The Company believes it will continue to exceed all expected well-capitalized regulatory requirements upon the implementation of Basel III.

Critical Accounting Estimates

The accounting policies followed by the Company and its subsidiaries conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our Consolidated Financial Statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP.

We believe that our most critical accounting policies, which involve the most complex subjective decisions or assessments, relate to allowance for loan losses, other-than-temporary impairment of investment securities, derivatives, income taxes, pension and other post-retirement benefits and share-based compensation. None of the Company's critical accounting estimates have changed during the quarter. Additional accounting policies are more fully described in Note 1 in the "Notes to Consolidated Financial Statements" presented in our 2012 Annual Report on Form 10-K. A brief description of our current policies involving significant judgment follows:

Allowance for Loan Losses: The allowance for loan losses is established as embedded losses are estimated to have occurred through the provisions for losses charged against operations and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. Management's judgment in determining the adequacy of the allowance is inherently subjective and is based on past loan loss experience, known and inherent losses and size of the loan portfolios, an assessment of current economic and real estate market conditions, estimates of the current value of underlying collateral, review of regulatory authority examination reports and other relevant factors.

Although management believes it uses appropriate available information to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation.


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Other-than-Temporary Impairment of Securities: The Company maintains a securities portfolio that is classified into two major categories: available for sale and held to maturity. Securities available for sale are recorded at estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Held to maturity securities are recorded at amortized cost. Management determines the classifications of a security at the time of its purchase.

Quarterly, securities with unrealized losses are reviewed as deemed appropriate to assess whether the decline in fair value is temporary or other-than-temporary. The assessment is to determine whether the decline in value is from company-specific events, industry developments, general economic conditions, credit losses on debt or other reasons. Declines in the fair value of available for sale securities below their cost or amortized cost that are deemed to be other-than-temporary are reflected in earnings for equity securities and for debt securities that have an identified credit loss. Unrealized losses on debt securities with no identified credit loss component are reflected in other comprehensive income. In the first six months of 2013, the Company did not experience any losses which were deemed to be other-than-temporarily impaired.

Derivative Instruments and Hedging Activities: The Company uses derivatives to manage a variety of risks, including risks related to interest rates. Accounting for derivatives as hedges requires that, at inception and over the term of the arrangement, the hedged item and related derivative meet the requirements for hedge accounting. The rules and interpretations related to derivatives accounting are complex. Failure to apply this complex guidance correctly will result in the changes in the fair value of the derivative being reported in earnings.

The Company uses interest rate swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the standard methodology of netting the discounted future fixed cash receipts (or payment) and the expected variable cash payments (or receipts.) The variable cash payment (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rates curves.

At June 30, 2013, derivative assets and liabilities were $6.3 million and $424,000, respectively. Further information about our use of derivatives is provided in Note 6, "Derivatives and Hedging Activities" in the Notes to the Unaudited Consolidated Financial Statements contained elsewhere in this report.

Income Taxes: The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. Some judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. In determining the valuation allowance, we use forecasted future operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations. Management believes that the accounting estimate related to the valuation allowance is a critical accounting estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance.

The reserve for tax contingencies contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various tax positions. The effective income tax rate is also affected by changes in tax law, entry into new tax jurisdictions, the level of earnings and the results of tax audits.

Pension and Other Post-retirement Benefits: Management uses key assumptions that include discount rates, expected return on plan assets, benefits earned, interest costs, mortality rates, increases in compensation, and other factors. The two most critical assumptions-estimated return on plan assets and the discount rate-are important elements of plan expense and asset/liability measurements. These critical assumptions are evaluated at least annually on a plan basis.

Share-based Compensation: The Company accounts for stock options and restricted stock based on the grant date fair value of the award. These costs are recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). The Company expenses the grant date fair value of the Company's stock options and restricted stock with a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria.


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The Company uses the Black-Scholes option valuation model to value stock options. Determining the appropriate fair-value model and calculating the estimated fair value of share-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life, expected dividend rate, risk-free interest rate and expected forfeiture rate. The Company develops estimates based on historical data and market information which can change significantly over time.

Operating Results

Executive Overview

Earnings for the second quarter of 2013 were $3.3 million, or $0.12 per diluted share, compared to $2.9 million, or $0.11 per diluted share, for the second quarter in 2012. For the six months ended June 30, 2013 and 2012, the Company recorded earnings of $7.9 million, or $0.29 per diluted share, and $6.8 million, or $0.24 per diluted share, respectively. The Company's results can be attributed to its continued business momentum characterized by solid revenues, balance sheet growth, in tandem with solid asset quality. The quarterly results include the impact of the net interest margin decline which is attributable to decreased yields on loans and securities in the continued low interest rate environment.

The increase in the Company's revenues over the second quarter in the prior year reflects the expansion of the mortgage banking business. The Company sold residential mortgage loans totaling $66.1 million in the second quarter of 2013 and reported net gains of $1.0 million, compared to $928,000 sold in the second quarter of 2012 with net gains of $44,000. For the six months ended June 30, 2013 and 2012 the Company sold residential mortgage loans totaling $128.8 million in 2013 and reported net gains of $3.1 million, compared to $18.5 million sold in 2012 with net gains of $569,000. Catalysts for this increase include the introduction of mortgage loan officers during 2012 into the mortgage banking business model to foster relationships with local realtors to target purchase mortgage production and decrease reliance on the refinance business and launching an online mortgage loan application solution to enhance the efficiency of the mortgage loan process. Additionally, the Company changed its accounting policy for mortgage servicing rights from the amortization method to the fair value method in the first quarter of 2013. The effect of the accounting policy change resulted in the Company recording approximately a $1.0 million increase in value for the mortgage servicing rights asset in the second quarter. The Company also benefited from an increase in revenue from its investment advisory subsidiary, Rockville Financial Services, Inc. ("RFS"). RFS recorded an increase in revenue over the prior quarter of approximately $160,000 as the reorganization of this subsidiary is beginning to gain traction.

The Company's tax-equivalent net interest margin for the three months ended June 30, 2013 was 3.48%, a decrease of 37 basis points over the same quarter of 2012. In the three months ended June 30, 2013 the Company received a commercial prepayment penalty of $367,000; excluding the commercial loan prepayment penalty, the tax-equivalent net interest margin was 3.41% for the second quarter of 2013. The tax-equivalent net interest margin for the six months ended June 30, 2013 was 3.48% compared to 3.83% for the same period in 2012. For the three months ended June 30, 2013 and 2012, the yield on earning assets declined 49 basis points to 3.99% and the cost of interest-bearing liabilities declined 19 basis points to 0.66%. The decline in the net interest margin was partially offset by an increase in average earning assets of 9.4%. The general year over year trends for the comparable six month periods impacting the margin includes a 47 basis point reduction in the yield on earning assets coupled with a 19 basis point reduction in the cost of interest-bearing liabilities. The margin decline was partially offset by the 11.5% increase in average earning assets. A sustained period of low interest rates is anticipated to continue, therefore, as interest-earning assets continue to originate or reprice downward, the net interest margin could be adversely affected.

The Company's strategy with interest rate risk management is to incrementally shorten asset duration and lengthen liability duration. Execution of this strategy contributed to the reduction of net interest margin in the second quarter of 2013 relative to the comparable period. During the second quarter of 2013, long term rates increased, while shorter term rates remained anchored due to continued easing by the Federal Reserve Board of Governors actions. This resulted in a steepening of the yield curve. Consequently, management decided to keep incremental wholesale funding short to take advantage of the curve steepening. Management has embarked on a measured strategy to incent retail customers to go out on the funding curve in an effort to neutralize the shorter duration funding that occurred due to management's actions and remain prepared for rising rates as well as act deyfensively to maintain and grow core deposits in the face of increased competitive pricing pressures from local competitors. During the quarter, the Company added adjustable rate securities to the investment portfolio that will react positively when market interest rates rise. Furthermore, the secondary market strategy of opportunistically selling long duration fixed rate residential originations without adding to the legacy higher-yielding residential portfolio has had a significant impact on the residential portfolio's contribution to net interest margin. With interest-bearing funding, the Company has exhibited price discipline with maturity deposits and other perceived rate-sensitive deposit products and is emphasizing low cost demand


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deposit generation. The success of this strategy will be dependent on the ability for the Company to reduce its cost of funds further. However, given the duration of the low interest rate environment and the actions taken previously to reduce rates on our deposit products will make it difficult to reduce the cost of funds in a meaningful way. The Company will continually reassess this strategy in light of new economic data releases and market expectations for changes to interest rates.

The asset quality of our loan portfolio has remained strong even as the leading economic indicators have provided mixed results as evidenced in part by the continued high unemployment and foreclosure rates throughout the country. The allowance for loan losses to total loans ratio was 1.14% and 1.15%, the allowance for loan losses to non-performing loans ratio was 137.55% and 115.08%, and the ratio of non-performing loans to total loans was 0.83% and 1.00% at June 30, 2013 and December 31, 2012, respectively. A provision for loan losses of $403,000 was recorded for the current quarter compared to $1.2 million for the quarter ended June 30, 2012. For the six months ended June 30, 2013 and 2012, the provision for loan loss expense was $794,000 and $1.9 million, respectively.

The Company will be aggressive in pursuing its strategic goals while practicing prudent risk management to achieve continued positive business momentum and success.

Selected Financial Data



                                                        For the Three Months Ended            For the Six Months Ended
                                                                 June 30,                             June 30,
(Dollars in thousands, except share data)                 2013                2012              2013              2012
Share Data:
Basic net income per share common                     $        0.13         $    0.11       $       0.29        $    0.24
Diluted net income per share common                            0.12              0.11               0.29             0.24
Dividends declared per share                                   0.10              0.09               0.20             0.17
Operating Data:
Total operating revenue                               $      20,808         $  19,150       $     42,199        $  37,946
Total operating expense                                      15,857            13,815             30,528           26,158
Key Ratios:
Return on average assets                                       0.64 %            0.63 %             0.76 %           0.74 %
Return on average equity                                       4.26 %            3.63 %             4.98 %           4.13 %
Tax-equivalent net interest margin                             3.48 %            3.85 %             3.48 %           3.83 %
Non-performing Assets:
Residential real estate                               $       7,521         $   8,087       $      7,521        $   8,087
Commercial real estate                                        1,126             1,624              1,126            1,624
Construction                                                  1,456             1,235              1,456            1,235
Commercial business                                             773             1,200                773            1,200
Installment and collateral                                       -                 33                 -                33

Total non-accrual loans, excluding troubled debt
restructures                                                 10,876            12,179             10,876           12,179
Troubled debt restructures-non-accruing                       2,461             3,071              2,461            3,071

Total non-performing loans                                   13,337            15,250             13,337           15,250
Other real estate owned                                       2,611             2,084              2,611            2,084

Total non-performing assets                           $      15,948         $  17,334       $     15,948        $  17,334

Non-performing loans to total loans                            0.83 %            0.98 %             0.83 %           0.98 %
Non-performing assets to total assets                          0.73 %            0.90 %             0.73 %           0.90 %
Allowance for loan losses to non-performing loans            137.55 %          113.47 %           137.55 %         113.47 %
Allowance for loan losses to total loans                       1.14 %            1.11 %             1.14 %           1.11 %


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Average Balances, Interest, Average Yields\Cost and Rate\Volume Analysis

The table below sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. A tax-equivalent yield adjustment was made for the three and six months ended June 30, 2013 and 2012. All average balances are daily average balances. Loans held for sale and non-accrual loans are included in the computation of interest-earning average . . .

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